On public finances, Britain is still living in cloud-cuckoo land

Asked at the Spring meeting of the International Monetary Fund whether he
thought austerity had gone too far, Anders Borg, Sweden’s finance minister,
said there was really only one way to avoid painful fiscal consolidation for
countries with very high debt and that was never to get yourself into such a
mess in the first place.

With debt approaching 90pc of GDP, Britain faces the next big downturn with virtually nothing in the way of fiscal shock absorbersPhoto: Alamy

This might seem a trite answer but it is what has instructed Swedish fiscal policy since the early 1990s, when the country faced a similar banking crisis, and consequent collapse in the public finances, to the one we are seeing in Britain, America and the eurozone today.

In marked contrast to almost everyone else in the EU, Sweden has ridden out the present financial crisis with hardly any impact on public debt. Even at the height of the crisis, the budget deficit never rose beyond 0.9pc and, by 2011, Sweden was back in surplus. For a country notorious for its very high levels of social spending, it was a remarkable escape.

But it was one that was achieved only because Sweden has form. In its very own banking crisis at the beginning of the 1990s, the deficit soared to 11pc, and gross public debt from 41 to 73pc, a trajectory very similar to Britain’s today.

The result was broad political consensus that never would Sweden allow itself to get into such a hole again. A tough new fiscal framework was established, which commanded support from both Left and Right, and essentially holds good to this day.

Despite the much deeper destruction of the current implosion, there is very little sign of the same consensus establishing itself in either Britain or America, while in the eurozone fiscal discipline is accepted only through gritted teeth as the price that must be paid for continued membership of the single currency.

In Britain, there remains a very sizeable political constituency, supported by a small but vocal group of economists, which rejects the case for fiscal consolidation altogether.

In a half-hearted sort of way, Labour has adjusted its position of late but there is still the same denial that fiscal policy under the last Government was in any way the cause of the present meltdown. Ruinously high levels of public debt are instead presented as just an unfortunate consequence of the banking crisis, not a problem in themselves.

Small wonder, then, that nobody believes Ed Miliband when he comes over all fiscally responsible. Gordon Brown was a good deal more convincing when he nailed himself to the cross of fiscal prudence in the run-up to the 1997 election but it didn’t stop him letting rip on an almost unprecedented scale.

According to an Institute for Fiscal Studies study ahead of the last election, Britain had the second highest rate of increase in public spending among 28 comparable industrialised countries between 1997 and 2007, and the highest between 2007 and 2010. At 4.4pc a year in real terms (that’s after inflation), it dwarfed the 0.7pc that had occurred during the previous 17 years of Tory rule. These very high levels of public spending became embedded so that, when the economy collapsed, it automatically ratcheted up to an almost unprecedented peace time record of nearly 50pc of GDP. Predictably, all this extra spending was accompanied by steeply falling public sector productivity such that, had levels of productivity inherited in 1997 been sustained, the same amount of public service provision could have been bought for £42.5bn a year less by 2007 than it cost. Alternatively, service provision could have been 16pc higher.

Nor was this an isolated case of delusional levels of public spending. Boom and bust in the public finances have been a repeated feature of Britain’s post-war economic landscape with at least two other incidents of it in recent times, one of which – in 1976 – culminated in a humiliating IMF bail-out.

You would think that by now the penny might have dropped, with broad political agreement to submit to Swedish-style fiscal disciplines, but no. With Labour, it is perhaps to be expected, yet the Coalition is scarcely much better.

The decision to abandon the debt target and let automatic stabilisers operate in response to economic stagnation has rendered the broader “fiscal mandate” almost meaningless. The Office for Budget Responsibility has succeeded in making the public finances more transparent and accountable but it lacks the political clout of its Swedish mentor, the Finanspolitiska radet, or Fiscal Policy Council.

There are no sanctions if the Government deviates from target, or even seemingly any damage to reputation. On the contrary, the Government is mainly praised for doing the sensible thing by allowing the timetable for consolidation to stretch ever further into the future.

This is all very well but the longer painful choices are delayed, the more dangerous the position becomes. With debt approaching 90pc of GDP, Britain faces the next big downturn with virtually nothing in the way of fiscal shock absorbers.

It is true that Britain has had much higher levels of public debt relative to national income in the past but these periods have been associated with major wars after which, with demilitarisation and the revival of consumption-led growth, the problem becomes largely self-correcting. No such remedy is available this time.

Nor are the longer term fiscal challenges posed by declining North Sea Oil production and the costs of an ageing population being taken anywhere near seriously enough by today’s political class.

When the OBR releases its annual “fiscal sustainability report” (again based on a Swedish counterpart) on Wednesday, there will be great alarm over the rising pension and healthcare costs it predicts but nothing will be done. The publication date, at the start of the summer holidays, makes the contents all the more forgettable.

Policymakers work within a time horizon which stretches only as far as the end of the next spending review. What happens thereafter is for others to worry about. Little cognisance is taken of the long-term liabilities that today’s decisions are building.

To be fair, the Government’s pension reforms ought to be relatively effective at capping the future costs of the state pension – in marked contrast to many other European countries – but rising healthcare and other costs associated with ageing remain largely uncharted waters.

Just to give a taste of what’s in store, a recent House of Lords report estimated that there would be 51pc more people over the age of 65 by 2030 than there are now, and double the number of over-85s. Also doubled will be the number of people with dementia, while those with more than three chronic medical conditions, requiring persistent treatment, will have risen 50pc by 2018.

Perhaps the OBR is trying to be gentle on us but, in its already alarming enough projections of rising debt from 2030 onwards, it assumes healthcare spending increasing only in line with real incomes, with the shortfall absorbed by some truly heroic levels of productivity gain in the NHS. Dream on.

The upshot of all this is that Britain as a nation – households as well as government – needs to be saving far more than it is to finance future growth and the blessing of rising life expectancy.

Yet public policy does the reverse. In order to sustain current spending, it penalises saving and celebrates profligacy.